William Hague, the Foreign Secretary, today admitted that Britain had dropped its threat to formally block use of the EU institutions by the fiscal pact.

The news was criticised by pressure group Open Europe, which said the decision set a “worrying precedent”. Mats Persson, a spokesman for the campaign group, said: “The reality is that it is very limited, but its sets a worrying precedent.”

Priti Patel, backbench Tory MP, added: “I am alarmed by this, and anything that sets a precedent of this nature. It is a matter of serious concern. On areas of this nature, there should be no room for compromise.”

The fiscal pact countries, led by France and Germany, want the European Courts of Justice to police new rules which limit the amount of debt they can wrack up.

British Government lawyers have advised that it is technically illegal to allow the ECJ to police the ‘debt brake’ rule because it is not in the current EU treaty.

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But senior British officials reassured other EU countries on Friday night that David Cameron would not pick a fight over the issue during the summit, which starts today.

Mr Hague said : “This group cannot cut across the EU treaties. If the use of the EU treaties at any point threatens Britain's fundamental rights under the EU treaties, or damages our vital interests such as the single market, then we would have to take action about that, including legal action.

"So we will reserve our position on the specific question about the use of the court.”

Downing Street denied that the Government had abandoned opposition to the 26 countries using the EU institutions. The countries signing up to the new treaty would be welcome to use the institutions so long as they did not “undermine” the European single market,she said.

A Number 10 spokesman said: “The Prime Minister has always been clear that we would approach the issue constructively. The position hasn’t changed.

“The fundamental principle here is Britain’s national interest. Our national interest is to ensure that the single market is not undermined. The institutions are there to operate in the interests of the 27.

“If the single market, and therefore our national interest, is undermined, then we would want to take further action.”

The latest and fourth draft of a “Stability, Coordination and Governance (SCG) Treaty” will be given political agreement today, probably with some amendments before being signed in March.

The SCG treaty “empowers the Court of Justice to verify the transposition of the balanced budget rule at national level”.

“The current draft gives the court the authority to impose financial sanctions in case a contracting party was found by the court not to have taken the necessary measures to comply with its judgement,” says an EU paper on the text.